Page 191 - Encyclopedia of Business and Finance

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Cost of Living Index

erally quantifiable and thus appear to be objective. How- alternatives that are appealing. All types of entities,
ever, it is not uncommon for qualitative factors to enter including businesses, not-for-profit organizations, and
into the decision-making process. For example, providing governmental units, strive to improve the measurements
a product that individuals with limited incomes will be used in cost-benefit analyses. The capabilities of electronic
able to purchase may not provide the highest monetary equipment provide promising assistance in accumulating
return on investment in the short run, but might prove to data relevant for analyses. Wise use of resources is an
be a successful long-term investment. Careful decision important goal in every organization; cost-benefit analyses
makers attempt to deal with a difficult-to-quantify factor make a key contribution to this goal. Therefore, attention
in as objective a manner as possible. However, cost-bene- is given to improving both the effectiveness and efficiency
fit analysis in most situations continues to introduce of such analyses.
measurement problems.
BIBLIOGRAPHY
COST-BENEFIT ANALYSIS IN Boardman, Anthony, E. (2006). Cost-Benefit Analysis: Concepts
NONBUSINESS ENTITIES and Practice. Upper Saddle River, NJ: Pearson/Prentice-Hall.
Nas, Tevik F. (1996). Cost-Benefit Analysis: Theory and Applica-
Cost-benefit analyses are also common in nonbusiness tion. Thousand Oaks, CA: Sage Publications.
entities. Boards of not-for-profit organizations establish
priorities for their programs, and such priorities often
specify desired program outputs. For example, assume a Mary Michel
not-for-profit organization is interested in reducing the Mary Ellen Oliverio
level of illiteracy among the citizens of a rural community
in a state that has one of the lowest per-capita incomes in
the United States. As alternative programs for those who
need to learn to read are considered, there will be cost- COST OF LIVING INDEX
benefit analyses that focus on a number of factors, includ- SEE Consumer Price Index
ing the extent to which a particular program can attract
those who are illiterate. A program in the downtown area
of a small town might be considered because a facility is
available there at low cost, and that low cost is appealing. COST-VOLUME-PROFIT
Focus on cost is not sufficient, however. When benefits are ANALYSIS
considered, it might become clear that those who are eager
Cost-volume-profit analysis (CVP), or break-even analy-
for such a program do not have cars and that there is no
sis, is used to compute the volume level at which total rev-
public transportation from where they reside to the center
of the small town. Further consideration of relevant fac- enues are equal to total costs. When total costs and total
tors and of alternatives, undertaken in good faith, should revenues are equal, the business organization is said to be
result in cost-benefit analyses that provide valuable infor- breaking even. The analysis is based on a set of linear
equations for a straight line and the separation of variable
mation as the agency makes decisions.
and fixed costs.
At all levels of government in the United States, cost-
Total variable costs are considered to be those costs
benefit analyses are used as a basis for allocating resources
that vary as the production volume changes. In a factory,
for the public good to those programs, projects, and serv-
production volume is considered to be the number of
ices that will meet the expectations of citizens. For exam-
ple, decision makers at the federal level who have policy units produced, but in a governmental organization with
responsibility for environmental standards, air-quality no assembly process, the units produced might refer, for
example, to the number of welfare cases processed. There
rules, or services to the elderly often find information
are a number of costs that vary or change, but if the vari-
from cost-benefit analyses to be critical to the decision-
making task. ation is not due to volume changes, it is not considered to
be a variable cost. Examples of variable costs are direct
materials and direct labor. Total fixed costs do not vary as
CONTINUING EFFORTS TO volume levels change within the relevant range. Examples
QUANTIFY COST-BENEFIT of fixed costs are straight-line depreciation and annual
FACTORS insurance charges. Total variable costs can be viewed as a
As possibilities for the use of funds increase, there is moti- 45° line and total fixed costs as a straight line. In the
vation for better measurement of both costs and benefits break-even chart shown in Figure 1, the upward slope of
as well as for speedier ways of accomplishing analyses for line DFC represents the change in variable costs. Variable

168 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION